2009-06-06

U.S.A. to sink into the abyss

Caijing covers the remarks of Richard W. Fisher, president and CEO, Federal Reserve Bank of Dallas
Congress, spurred on by the new president, has been aggressive with fiscal policy. The good news is that if fiscal policy has been properly designed — and time will tell if it has been — it should propel the economy farther away from the edge and put it on its way to a new cycle of economic growth, somewhat tentatively at first, but hopefully gathering momentum as time passes.

Unfortunately, that momentum faces a real, long-term threat from storm clouds on the horizon in the form of daunting fiscal imbalances.
Everyone with half a brain knows full well the fiscal policy is an Epic Fail. If it's supposed to keep the U.S.A. out of the abyss...
That deficits will be high over the next few years seems clear, with a US$ 1.8 trillion deficit expected this year and US$ 3.8 trillion in new debt issuance now forecast over the next five years. Perhaps more importantly, annual deficits exceeding half a trillion dollars are projected for at least 10 years into the future, emphasizing that we as a nation will continue to spend considerably more than we take in long after the current economic crisis.
Debt issuance will exceed $2.5 trillion in FY2009 alone based on current trends. Annual deficits of $1 trillion are more likely than not for the next 10 years...
The country's major newspapers recently reported with great urgency the administration's finding that Social Security would begin spending more than it takes in by 2016 — seven short years from now. Left unreported was the fact that the discounted present value of entitlement debt, over the infinite horizon, reached US$ 104 trillion. This is almost eight times the annual gross domestic product of the United States — and almost 20 times the size of the debt our government is expected to accumulate between 2009 and 2014.

Most of this entitlement shortfall comes from Medicare rather than Social Security. As you may know, Medicare has three main components: Part A for hospital stays, Part B for doctor visits, and Part D for prescription drugs. The fiscal shortfall for Part A alone is US$ 36.4 trillion — about one-third of all entitlement debt. Part B's shortfall is just a tad larger, clocking in at US$ 37 trillion. Part D — the latest addition to the Medicare program — registers a shortfall of US$ 15.5 trillion. And Social Security, the program about which various reforms have been so frequently mooted in recent years, registers a deficit of US$ 15.1 trillion — only one-seventh of the total unfunded liability from entitlement programs.

This fiscal predicament is a looming budgetary threat to our long-term economic prosperity. And while the announcement that the Social Security trust fund will begin its decline one year earlier is an important fiscal event, the swelling of overall entitlement debt to more than US$ 100 trillion has far more serious implications for economic growth — implications we are poorly positioned to address given the budget deficits we face today.
These numbers pop up everywhere and it's obvious that there will be major tax increases or benefit cuts. With the current composition of government, higher taxes are likely, which will cause slower growth and cause the other tax revenues to fall. Not only that, but Social Security and Medicare are consumption, not investment. The higher taxes will suppress investment, leading to yet lower economic growth.
Our successor generations are coming to grips with this daunting reality. Faced with the prospect of a government that they believe may be unable to deliver on its promise of long-term fiscal balance — particularly with regard to entitlement programs — these individuals might logically begin to alter their consumption patterns, spending less today to save more for tomorrow. There is nothing wrong with increasing savings. But in an economy driven by consumption, this inter-temporal hedging may dampen the pace of future economic growth.
Not only that, but they're moving their assets out of the country or hiding them in other ways.
Of course, any student of history knows that through time, governments unwilling to face the music and fund their liabilities have turned to monetary authorities to print their way out of their predicament. We all know by heart the pathologies that afflicted Weimar Germany, Argentina and other countries. And we have daily reminders from bond vigilantes like Bill Gross about the prospect of losing our AAA rating. This cannot be allowed to happen in America, which is why I am pleased to see that the new administration has embraced what was hitherto perceived as the third rail of American politics and brought the issue of unfunded entitlement liabilities to the fore. For the sake of our grandchildren, I hope that the administration and the Congress will take this vexing beast of a problem by the horns and tame it.
You mean the Administration that wants to increase health care spending by hundreds of billions of dollars, with no plan for reducing costs?
Against that background, it is important that monetary policymakers be especially sensitive to concerns voiced about the dramatic expansion of the Fed's balance sheet in an era of high deficits.... [Liaquat] Ahamed speaks of the miscalculations of policymakers. [Paul] Volcker warns that the Fed cannot monetize deficits without heightening fears of inflation and negatively impacting the future course of interest rates.
The Fed may have taken an overdose of Novocaine.
Those of us responsible for developing monetary policy must constantly bear both observations in mind. We have been very careful to calibrate our actions so as to accommodate the needs of credit markets and the economy — not political imperatives. We are well aware that some of our balance sheet additions, designed to pull markets and the economy from the edge, have raised a few eyebrows (like the US$ 1.25 trillion in mortgage-backed securities we have pledged to purchase if necessary, although it has unquestionably driven mortgage rates to historic lows). And while it is not unusual for the System Open Market Account to buy Treasuries along the yield curve, the Federal Open Market Committee's (FOMC) decision to purchase US$ 300 billion in U.S. Treasuries — a decision made to improve the tone in private credit markets — has been viewed by some as skating a little too close to the edge of political accommodation.

I can tell you that the FOMC is well aware of the doubts being voiced about its intentions. I can also tell you that nobody I know on the committee wants to maintain our current posture for any longer and to any greater degree than is minimally necessary to restore the efficacy of the credit markets and buttress economic recovery without inflationary consequences. Indeed, as I speak, we are studying ways to unwind our balance sheet in a timely way.

In the meantime, looming before us is the prospect of a heavy calendar of debt issuance by the Treasury. Between now and the end of the current fiscal year in October, the Treasury will issue just over US$ 1 trillion in net new debt, with at least that much to follow in fiscal 2010. As the Book of Volcker warns, the Federal Open Market Committee can ill afford to be perceived as monetizing debt, lest we come to be viewed as an agent of, rather than an independent guardian against, future inflation and drive real interest rates higher.
You're there, right now. I don't know when, I don't know the specifics, but socially and psychologically, a major run on the U.S. dollar can happen at any moment because no one believes the Federal Reserve.
You may wish to note that, press and analysts' reports to the contrary, a keen student of the H.4.1 and the Foreign and International Monetary Authority (FIMA) custody holdings reports of the Fed will detect that foreign official holdings of U.S. Treasuries and agencies have been growing at a robust pace, not shrinking. And from what I can detect from the activity of so-called indirect bidders in Treasury auctions — indirect bidders submit competitive bids through others rather than directly; central banks are among those who commonly bid indirectly — there continues to be strong demand for longer duration Treasuries, again contrary to rumors and press reports. Thus, to date, our actions have not given rise to concern that we will violate Paul's Dictum.

This is important, for there are concerns in some quarters that the Federal Reserve will be politicized. For example, there have been suggestions that Congress should be involved in the selection of Federal Reserve Bank presidents, who, unlike the seven members of the Board of Governors, are not appointed by the president nor confirmed by the Senate. I trust that Congress will resist this initiative and not upset the careful federation that has for so long balanced the interests of Main Street with those of Washington, just as we at the Federal Reserve must resist the urgings of some to accommodate the short-term financing needs of the Treasury.

Your central bank has worked hard to pull the economy back from the abyss. To be sure, the FOMC has taken risks to do so. We have no doubt erred on occasion, but for the most part, I think we have gotten it right, primarily because each of us has an abiding faith in the time-tested virtues of conducting responsible monetary policy. We will work hard to remain virtuous, always bearing in mind that our job is to conduct monetary policy with the simple yet profound mission of underpinning sustainable economic growth without sacrificing price stability.
The Federal Reserve has built a bridge out of rotten logs across the abyss, and Barack Obama and the congressional Democrats, with the help of plenty of moderate Republicans, plan to drive a fleet of tanks across the bridge.

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